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Month: February 2012

This article from the Economist struck me like a bullet on reading it today. Not so much for the subject matter itself (US banking practices) but what the whole episode says about the modern world. We have never had more data readily available on people – but we seem less able than ever to take decisions on their individual merits. More data, less information. This problem is usually shrugged off y economists and reformers with a laugh; it shouldn’t be.

The story starts in the US property boom, when banks were falling over themselves to offer mortgages, based on the vague idea that since these loans where secured on property, and property values always go up, you couldn’t have too much. The banks stand accused of approving loans robotically, without any consideration of individual merits – and as a result often lending to people who could not afford to keep up with the repayments. This accusation was commonplace, but, as the article points out, little effort seems to have been made to substantiate it against hard evidence.

Then came the crash, and many people who had taken out loans could not or would not keep up with the repayments – and stood at risk of having their homes repossessed. And the banks once again stood accused of carrying out repossession without due care and attention, again on mainly anecdotal evidence. This became a hot political issue, and the individual US states set about suing the banks, with the Federal government becoming involved too. And now an umbrella settlement is proposed, to which the five main US banks and 49 out 50 state Attorney Generals have agreed to. The banks are making a blanket payment to make the problem go away.

What remains characteristic of the whole story, from the original alleged malpractices right up to the settlement, is a failure to reconcile it to what actually happened to real people in real homes. No attempt is made to distinguish between whether some banks are more culpable than others; and no attempt to distinguish between arrears that arise from people in genuine hardship, and those who are trying to beat the system. All that is just too difficult.

And this type of thing is happening all around us. Decisions are made about us using computer algorithms based on data that may or may not be accurate – or based on our membership of some or other broad group of people (men, women, over 50, etc.) and the law of averages. Companies calculate that it is cheaper that way. To consider people as real people, and base decisions on the individual merits of the case, well that requires the intervention of skilled staff, and they cost a lot of money.

And so the flip side to ever advancing productivity (one of the things that makes skilled people cost so much) is that we are subjected to an increasing volume of de-personalised services and arbitrary decisions; and around the fringe a spectrum of fraud arises, as people learn to take advantage of system weaknesses. I have been the subject of mild identity theft several times; this looks quite safe for the people who perpetrate it, since nobody bothers to find them – it’s just a cost of doing business.

But what’s the moral of the story? We gain a lot from the increased wealth that arises because of all this added productivity. And what’s more part of becoming a more equal society is that well off people like me can’t expect to have armies of people running around fawning on their every need. So should I just stop whinging, and get on with all the things I can now do that would have been unthinkable in a previous age?

Up to a point. I think there are two important consequences that many people overlook. One big picture, and the other of more urgency. The big picture point is that are are physical limits to economic growth, and it is no wonder that the pace of growth slows in developed societies. Higher productivity means we consume more services with diluted human content. But huge part of the pleasure we derive from some services is exactly because we get one-on-one attention from somebody (hairdressing perhaps, a personal trainer, dinner at a posh restaurant, and so on); as productivity advances, the proportion that these non-negotiable services comprise in the total economy rises – and so growth slows. Economists refer to this as “Baumol’s Disease” after the economist who originally pointed it out. But it is not a disease; it is the product of success – it’s the process of arriving at the promised land, so to speak – the place that is so good that progress is impossible. An increasing proportion of services cannot be improved without detracting from their value, and people will resist buying them at any price; and that’s saying nothing of the distortion to incentives that arises from making decisions based on averages. We can’t rely on economic growth to wash away society’s problems – we need to confront them more directly.

The more urgent point applies to the reform of public services. Too many people assume that to make these more effective we must follow a similar process of sucking the human content out of them as we see in so many commercial services. In some cases I’m sure that’s true; some Indian organisations are doing amazing things to improve the productivity and effectiveness of certain medical procedures by using economies of scale. But in most cases the effectiveness of public services depends on joining up the dots; seeing people as people rather than collections of unrelated needs that can be picked off one by one. An individual who is committing serial antisocial behaviour offences, may have mental health problems, addiction issues, a dysfunctional family life, educational under-achievement, and inadequate housing. Just from listing them you can see how all these problems are interrelated and feed off each other. We stand a much better chance of making progress if we design solutions based on looking at this individual and his exact personal circumstances and negotiating with him as a human being. Productivity in public services is not about rate of throughput, its about solving problems and reducing demand. This needs a completely different mindset than that needed from the commercial world. Alas too much (though certainly not all) public service reform misses this key point.

Everybody agrees that the UK economy needs more growth, like pretty much every other developed economy. On the right it seems to be taken for granted that cutting corporate taxes will help. This view deserves to be challenged.

An example of the argument for lower tax rates is this one from Tim Knox on the LSE website, promoted by the conservative think tank CPS. Mr Knox suggests cutting the main rate from 28% to 20%, while simplifying a lot of the deductions. The logic is simple. The economy needs businesses to invest and expand. A high corporate rate of tax is a disincentive to do so; a cut in rates would give businesses a shot of confidence that would get them moving.

This line of reasoning is not nonsense – and his ideas for simplifying the system on capital allowances and capital gains may make sense, though would be fiercely contested by lobbyists. There is a lot nonsense talked about corporate taxes. Companies aren’t people, and the payments companies make to people are taxed as employment or investment income. There is quite a cogent argument (a classic essay topic for undergraduate economics students) that companies shouldn’t be taxed at all – though this would certainly open up opportunities for tax avoidance.

But a different way of looking at the predicament of the UK economy comes from Martin Wolf in the FT (paywall, I’m afraid). He points out that one of the macroeconomic problems with the UK economy is the large value of the corporate surplus – in other words businesses are making too much profit and not spending enough. He agrees with Andrew Smithers of Smithers and Co who published a report entitled “UK: Narrower Profit Margins and Weaker Sterling Needed”. Mr Wolf does not advocate raising corporate taxes, but he nevertheless poses an awkward question for those who advocate a cut. The basic macroeconomic problem for the UK is that the government deficit is too high and its mirror image is a corporate surplus that is also too high. Going back to Year 1 Economics, you can’t cut one without cutting the other (not entirely true, but the alternatives involve private individuals getting even more indebted, or an unrealistic export surplus). How on earth does cutting corporate taxes help, without using voodoo concepts like the Laffer Curve?

In fact economically corporate tax is one of the more efficient ones in microeconomic terms – it does not distort incentives as much most other taxes, because it is based on profits, not inputs or outputs. It amounts to a tax on capital – but capital is already having it very easy in the world economy, one of the drivers of increased inequality within nations (as opposed to between them…).

Strategically we should be thinking of more ways of taxing companies, on the basis of “use it or lose it” – it isn’t healthy for companies to sit on surplus profits. A logical way would be to raise the tax rate but make dividends deductible – but this is probably a nightmare in practice. Another idea is to cut the tax relief for debt interest – which would help restore the balance between debt and equity funding. In the long term this would no doubt be very healthy and discourage companies from becoming over-indebted; in the short run it would be a bit like bayoneting the wounded after the battle, so implementation would need a great deal of care.

But even if either of these ideas look impractical, the argument for cutting the tax rate looks distinctly weak.

The launch of two new policy focused groups within the Lib Dems in the last couple of weeks has drawn a bit of comment in the party. But the striking thing to me is what all this says about how the party has evolved since it was formed by a merger between the Liberal Party and the SDP.

The first new group, and the one that has drawn most comment, is the Liberal Left. This group’s raison d’etre is opposition to the coalition with the Tories, now or ever. It is social democratic in policy instinct, and sceptical of economic austerity policies; it rails against that convenient abstract noun “neoliberalism”. The second group is Liberal Reform. I am rather less clear what this one is really about; it says it is about promoting “four cornered freedom – personal, political, social and economic liberalism”. I think it for people who think in an economically liberal way, and are inclined to support the coalition and the general thrust of government economic policy, but also have strong social liberal instincts – people like me, in fact.

These are distinct from two other groups: the very successful Social Liberal Forum, set up to counterbalance some of the economically liberal conventional wisdom amongst Lib Dem ministers and their entourages – it has struck a chord with the grumbles of many activists. Then there is Liberal Vision, much more of a minority interest, economically liberal and seemingly a fellow traveller with Germany’s Free Democrats, distinctly to the right of that country’s political spectrum. All these group build, perhaps, on the trail blazed by the Green Liberal Democrats, from whom one hears rather little these days…but which in its day was prominent in the promotion of environmentalism.

One Lib Dem on Twitter is dismayed. He left the Labour party because of its factionalism, and now look what happening to the Lib Dems! Political factionalism is very much a personal rivalry game. The different factions are relatively tight networks of individuals with patronage powers, who partly define themselves by loathing of rival groups. I don’t quite detect that with these groups, which tend to overlap with each other. This, at least to this outsider, looks more like a battle of ideas, and is not unhealthy. I worry that the Liberal Left (and the SLF) are more against things than they are for them, but that’s probably unfair. And there have been a few insults traded across the social media, e.g. suggesting that the Liberal Left are just unreconstructed oppositionalists. Plus the all those references to “neoliberalism” from the other side. That is just a dimension of debate, though – there’s a lot more reasonable discussion going on too.

But taking a step back, there are some rather striking things about the phenomenon. First is the emergence of the word “Liberal” to describe the party and what it stands for. The “Democrat” bit, a token gesture to the old SDP as it merged with the Liberal Party in 1987, is slowly dying out. But old Liberals can’t take any comfort from this, since the defining features of the 1980s Liberals, community politics and environmentalism, get very little mention. Instead we have various visions of social democracy (a strong state standing for fairness) and economic liberalism (a greater faith in appropriately regulated market solutions), both more characteristic of the old SDP.

Community politics is increasingly forgotten. What was it? It was politicians getting things done by taking a leadership role in their local communities – talking, listening, cajoling, organising to make things better, while still standing firm on core liberal values. To the modern politico this is so yesterday. Much more fun to discuss grand policies, new laws, political strategies, market positioning and so forth. Perhaps this is an inevitable result in the decline of local communities, especially in poorer areas – part of the alienation of the modern quest for efficiency. Pockets of community politics persist (the highly successful Sutton Lib Dems for example) and hopefully will keep the flame burning. But while most activists will pay token homage to the idea, it isn’t what keeps them awake at night.

Since the merger (disclosure – I was a founder member of the SDP), genuine liberalism (an emphasis on personal freedom and internationalism) has come to define the party much more clearly than it ever did in the old SDP. But other than that I have to say that the new party is growing more like the old SDP than the old Liberals. I’m not sure if that’s a good thing. The old Liberal ways had grown on me.

The savages are circling around Andrew Lansley and his NHS reforms. Or translated into something more politically correct, the indigenous tribes have cornered the contemptuous invader, and are closing in for the kill.

Stories have been floating in the press that David Cameron is about to sack Mr Lansley and give way on most of his reforms, and particularly those that need legislative approval. Mr Cameron’s expressions of “full confidence” cuts little ice in this football-mad country, where club chairman habitually express full confidence in managers the day before sacking them. Mr Lansley and the reforms appear friendless. The various medical lobbies are building up against them; every few days another comes out against. The Tory press is hostile to indifferent. Lib Dem colleagues are urging me to sign a petition against the Health & Social Care Bill which is at their centre.

I can’t quite bring myself to sign, as somebody that basically supports reform. But I now think that they were a political mistake not really worth fighting for. And that may well be Mr Cameron’s view too. The risks of persisting with it are rising. There seems little chance of things settling down in time for the 2015 election, by which time chaos in the NHS could well be a top political issue. When the Coalition took over, the NHS had recovered its previously poor political standing. So far as the public was concerned, it wasn’t broke so didn’t need fixing. On the other hand if the government U-turns now, there is quite a good chance that the matter will blow over. Financial crises and hospital closures are bound to continue, but the whole thing will be rendered less toxic without these reforms to blame for everything. The political calculation seems quite clear, which is why a growing number of Tories are pushing for Lansley to go.

What would happen if Lansley went and the Bill was dropped? The new health secretary would be left with an enormous amount of executive power to continue a reform process – after all that is why the administrative reforms have made so much progress without the Bill becoming law. Ironically a lot of the Bill was about curbing this executive power and making it more accountable. But the focus of reform would be explicitly to make the service more efficient as demographic changes place it under ever more pressure. This would be a lot more difficult for Labour to attack, since that was what they were saying when in power.

It hasn’t happened yet, of course. I feel a bit disappointed that things have come to this. I dislike much of the criticism that the reforms have attracted, and especially to the resistance to the use of private sector providers, and the sharing of facilities with fee paying patients. The current NHS comprises a lot of good services swimming in a sea of mediocrity, and it has reached the limit of what can be provided if funded only from taxation. The GP side in particular is inefficient and lacks accountability. Beneficial changes require extraordinary amounts of effort to implement. There was a lot of nonsense and gobbledegook in the PCT-led commissioning introduced by the last government, largely designed by management consultants.

Still the reform process was too broad and too fast, and became ever more muddled as the process encountered resistance. I won’t mourn its passing.

Some Tories are talking up the idea that the Coalition between their party and the Lib Dems should continue for a second term. This doesn’t sound realistic. And I think it would be a bad idea too.

Some pundits have claimed that Britain’s major parties (aside – I am thinking particularly of the three UK parties here, but there are similar dynamics with the SNP too) have become more alike and simply compete on competence (I often tread this in the Economist, for example). This may be true so far as they way that they each reach out to a group of critical floating voters, but in fact each has a very different view of the world. And it makes a difference which one of them is in government.

That was why it was such a surprise that the Liberal Democrats went into Coalition with the Conservatives in 2010, and why it has been, and remains, so painful for them. To the Lib Dems, the Tories are on the wrong side of a great historical struggle that still shapes our politics. The Tories stand for the rich, cleverly roping in those who aspire to be rich, and social conservatives and nationalists in a coalition of nastiness. The stakes in this battle are rising, since, for whatever reason, the rich have been doing very well over the last couple of decades, and have a lot to protect. Redistribution, in some shape or form, should be high on the political agenda.

The Lib Dems are essentially liberal; they have some fellow feeling with the aspirant well off (or should do), but have historically been the other side of the rich-poor divide – and find social conservatives and nationalists anathema.

But in 2010 the party had little choice. In its own way Labour was on the wrong side of history too. Labour is the party of big government, and its core constituency is public sector managers and workers, the quangocracy and the many organisations that feed off tax funding. The unions are heavily associated with these same interest groups, so its historical alliance with them does not cause undue strain. And just as the Tories marshal social conservatives to keep the show on the road, so Labour marshal those who depend on state handouts, without any real interest in curing them of their dependency.

The first decade of this century proved a happy time for Labour. The economy grew steadily, increasing the tax take, allowing the government payroll, direct and indirect, to expand, as well as the net for all sorts of benefits. To many within the party it must have seemed that they were on an unstoppable march to solving the country’s problems through government action.

But it was a castle being built on sand. Economic growth was not built on substantial advances in productivity, but on a combination of debt and good luck. We should note that most of the debt in question was in the private sector, but it is also true that government debt expanded more than was prudent. The good luck (consciously exploited Labour’s leaders) was the expansion of China and India, and the gains from trade that followed as costs of manufactured goods in particular advanced at well below the general inflation rate. In addition immigration from Poland and other central and east European countries stopped the British labour market from breaking down, and expanded the overall tax take, if not income per head (a matter of some controversy). All this has come to an abrupt halt, so that we are being forced to unpick many of Labour’s advances.

The shock to Labour supporters of finding that their dreams were built on air has been enormous. In 2012 they still mostly don’t really seem to believe it; in 2010 they were in such deep denial they were absolutely unfit to be in government, even in coalition. There was no basis to work with the Lib Dems, whose general world view is somewhat closer to them than the Tories. Given the financial crisis, a coalition with the Tories was easily the best option available to the Lib Dems, with the added benefit of the party learning how to take part in government.

How will things look in 2015, when the next General Election is due? It is still a long way off, but another hung parliament looks quite likely. Labour’s problem is not just that they are on the wrong side of history, it’s that most of the electorate realise it. They instinctively know that Labour’s aspirations cannot be afforded, and that they have no real idea how genuine economic growth can be found, so their support is stuck. But they should still advance from their lows in 2010, making a Tory outright win very difficult to pull off.

And what of the Lib Dems? The general betting is that the party will fall back. A near wipe-out is certainly within the range of possibility, but more likely is a significant loss of seats to, say, 30 or so (from the current 57). The situation in Scotland, source of many Lib Dem seats, looks dire. The consequence of this is that being part of a coalition is very difficult to make work. It’s difficult enough with the current balance between the parties. Could you really have a Deputy PM with just 30 seats? Offered a coalition by the Tories, the party would be wise to turn it down and let them make their way as best they could as a minority. The financial crisis should not be anything like as severe as in 2010, so this will look a more realistic prospect. Coalition with the Tories, especially with reduced moral and actual authority arising from a loss of parliamentary seats, is simply too toxic to continue.

And coalition with Labour? It’s difficult to see how that would work in 2015 too. There would need to be a change in party leader, and not just because he is a hate figure in Labour circles. To the public changing sides without changing leader would stink to much of ducking and weaving just to maintain office; he would need to have pulled off a really good election result to be able to stay. Changing leader is best done while not in government. And the problem of not having enough MPs would still hold.

But what if the Lib Dems should do unexpectedly well in the 2015 election, maintaining or even increasing their representation? This would certainly give the party a new moral authority after all they have been through. But the toxicity of the Tories remains; they are simply on the wrong side of history. With an increased representation, the party may well have the choice of partners, and if so, it should try to strike a deal with Labour, and one that gives the party increased overall clout in government.

But if Labour had done so badly that a coalition with them is not feasible? This would be the Lib Dem opportunity to show that they are the true opposition to the Tories. The party should offer the Tories terms that they are unlikely to accept, and then let them stagger on as a minority. A tricky stunt to pull off, but surely better than five more years in government with the Tories, giving Labour yet another opportunity to recover?

After a period of relative silence the idea of “globalisation” is re-entering political commentary. But almost none of the commentators seem have seem to have grasped its dynamics – and that its pressure on developed economies is easing rapidly to both good and bad effect.

Maybe it’s Davos. But globalisation has been coming up a lot lately. It is the subject of this week’s Bagehot Column in the Economist, which claims that its effect lie behind a lot of the political debate in Britain. An FT article drew attention to recent speeches by President Obama and French Presidential hopeful Francois Hollande apparently attacking its effects. And the IPPR launched a heavy (108 page) report on The Third Age of Globalisation, recommending that Britain in particular develops a proper industrial strategy.

I have already worried about how much political debate centres on abstract nouns, in particular “capitalism” and “neoliberalism” (a favourite on the left). “Globalisation” has to be added to this list. It is much better for the debate to move to the concrete (income and wealth distribution, for example). But there is value in trying to unpick the concept a bit. And what arises from this, at least in my view, is that the globalisation process is changing in way that few commentators recognise.

“Globalisation” is used as a collective word to refer to three inter-related phenomena in particular: international trade, cross-border investment, and international finance. These three have worked together in the last couple of decades (the IPPR’s “third age”) to transform the world economy, with developing economies being at the heart of it. It is associated with positive outcomes: the rise of so many developing economies, and negative – the increase in inequality in developed and developing nations alike. But to understand how this process will evolve it is best to consider the trade aspect, from which all the rest flows.

The central phenomenon had been the growth of trade between less developed economies and more developed developed ones, with the former taking over the manufacture of many consumer goods, and also many services too. Economists find this type of trade particularly easy to understand: it is a straightforward application of the principle of comparative advantage, first described some 200 years ago by David Ricardo.

Comparative advantage is one of those ideas that tend to separate “proper” economists from those that just try to follow economics from newspapers. I think many of the latterle think it is similar to the much more familiar idea of competitive advantage – but it is quite different. Basically it says that benefits in trade between two economies arise when there are differences between them in the opportunity costs of producing different goods. So if one economy can produce 10 tons of wheat to one of beef, and another 5 tons, there are benefits in trade which each economy specialising in the good where it has comparative advantage. In this case the first economy has a comparative advantage in beef and the second in wheat. It makes no difference how efficient each economy is in producing either good. And a comparative advantage in one good means a disadvantage in another – unlike competitive advantage (which applies to individual businesses rather than to whole economies) where one party can dominate the other.

So this theory predicts that there will be trade between economies that are different to each other – which is why the trade between developed and developing economies is to easy to explain. Economists struggle in using the theory to explain trade between similar, developed economies – but that’s another story, and it is a different type of trade.

Developing countries have emerged with a comparative advantage in low and middle tech manufacturing. Developing countries typically have the balancing comparative advantages in higher-end goods and services, raw materials (where they have endowments) and agriculture. Of course what we notice is the very low wages in developing countries, which make us think that the whole business is unfair. But it is a sideshow, and very easy to explain using basic economics. Wage rates are low because the developing economy as a whole is massively unproductive. The manufacturing plants may be relatively efficient, but other industry, and especially agriculture, is so unproductive that it drags wages down for the whole labour market. If factories paid higher wages, nobody would man the farms and people would starve (to greatly oversimplify things). It takes some getting used to the idea that developed countries have a comparative advantage in agriculture, when so much of a developing country’s resources are tied up in the sector – but that is what is going on. Full free trade in agriculture would put most developing world farmers out of business – except where tropical conditions gave them an advantage (bananas, perhaps).

And here’s the point. As the developing economy advances this picture changes. More and more people come off the land, and agriculture becomes more productive. Wages across the economy rise, and the developing economy slowly comes to resemble a developed one. The gains from trade disappear. Trade continues but it is on much more equal terms and much more about the competitive advantage of particular businesses than about the circumstances of a whole economy.

And this is exactly what has happened. In the 1990s the globalisation trend was mainly about the so-called “tiger” economies, of Taiwan, South Korea, Hong Kong, Thailand, and so on. I remember Tory ministers wandering around saying how this country was under existential threat unless workers’ pay and conditions were cut so that we the country would be competitive. But eventually a South Korean firm decided to build a factory here because it was cheaper producing goods here than at home. South Korea had caught up. But as the Tigers caught up and went to the next phase, China and India entered the picture, and gave the process a boost. The two most populous countries in the world were bound to have a massive effect and the whole process accelerated.

But these countries are catching up. This is especially clear in China, where rising wages have become a big issue. This week’s Economist has a very interesting briefing on the subject. The same processes are visible in the rather more chaotic India too. In both cases the attention is shifting to raising the standard of living for the domestic population, rather than international competitiveness. The worm has turned.

And on to the next wave? There are plenty of less developed economies in the queue: Vietnam, Bangladesh, Pakistan, and various countries in Africa. But none have the size and weight of the big two. And it’s not just a matter of supply: the developed world is becoming that much bigger as new countries enter it – so impact of these poorer countries entering the market will be spread more widely; they will be busy exporting to India and China.

So the basic driving force behind the globalisation trend of the last 20 years is grinding to a halt. What effect does that have on us in the developed countries? The good news is that the pressure to offshore will ease, producing a bit more stability on our work landscape. The bad news is that the gains on trade will vanish. This has been an important part of the general rise in living standards in the last couple of decades, which we have been relying on to produce forward momentum to a greater extent than many realise. Another reason why the “new normal” is slower growth.

So the developed countries will stay grumpy, but more from the slowdown of globalisation than from its continued rise. But the big question is whether the trends to inequality will reverse. On that score things are much less clear.